Insurance-linked securities as novel natural catastrophe risk management instruments
To date, the majority of losses resulting from natural catastrophes have been due to the increasing insured exposure accumulation (from human and physical assets) that has arisen with economic growth and urbanisation. In the coming decades, climate change will be one of the many factors contributing markedly to the increase in economic, and as a consequence insured, losses.
When a natural catastrophe occurs, triggering a loss of life and extensive damage to infrastructure, the vulnerability of society and its assets is immediately brought to mind. The increasing natural catastrophe related losses experienced by society – in particular insurers, reinsurers and governments – further accentuate the vulnerability and its reach not only into the economic and financial system, but social and political systems as well.
Against this backdrop, it is clear that there is a greater need for novel risk management instruments, processes and techniques. In this regard, insurance-linked securities (ILS) solutions have been at the fore. The talk will consider the treatment of stochastic processes for the modelling of natural catastrophes and construction and pricing of ILS based on these processes. In this context, we will also address the issue of estimation and simulation of heavy-tailed power-law distributions. We will, furthermore, consider simple approximations to the prices of the instruments.